cdfa bny mellon development finance webcast series credit
TRANSCRIPT
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CDFA / / BNY MELLON DEVELOPMENT FINANCE WEBCAST SERIES Credit Enhancement: Letter of Credit & Bond Insurance Options
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Katie Kramer Director, Education & Programs Council of Development Finance Agencies Columbus, OH
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Using 501(c)(3) Bonds to Catalyze Social Impacts
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Panelists Tony Portuondo, Moderator BNY Mellon
Steve Eikenberry First American Bank
Scott Richbourg Build America Mutual
Chris Chafizadeh Assured Guaranty
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Using 501(c)(3) Bonds to Catalyze Social Impacts
Tony Portuondo Head of Public/Not-for-Profit Relationship Management BNY Mellon Jacksonville, FL
Information Security Identification: Confidential
MUNICIPAL BOND MARKET
TRENDS IN BOND ENHANCEMENT
Long Term Market Trends
Top Bond Enhancers
Market Outlook
JULY 30, 2013
Information Security Identification: Confidential
Municipal Market Bond Enhancement Trends
2
BOND ENHANCEMENT PEAKED IN 2005 WHEN 69% OF THE MARKET INCLUDED SOME FORM OF ENHANCEMENT.
BOND INSURANCE ACCOUNTED FOR 82% OF ALL ENHANCEMENT IN 2005, VS 26% FOR 1H2013, AND SAW A VOLUME DECLINE 0F 96% IN THAT PERIOD
LETTER OF CREDIT ENHANCEMENT PEAKED IN 2008, WITH $71 BLN IN NEW ISSUES
Data Source: Thomson Reuters as of June 30, 2013
44% 41% 43% 36% 31%
38% 41% 54%
83% 84% 83% 86% 87%
47% 50% 50% 55%
57% 50% 47% 19%
9% 6% 6% 4% 3% 5% 4% 4% 7% 7% 6% 5%
18%
5% 3% 4% 2%
5% 4% 3% 3% 6% 7% 7% 8% 4% 7% 8% 8% 9%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1H13
Am
ou
nt
($ M
ln)
Bond Enhancement As Percent of Entire New Issue Market
No Enhancement Bond Insurance Letter of Credit Other Enhancement
Information Security Identification: Confidential
Municipal Market New Issue Trends
3
BOND INSURANCE HAS SEEN A VOLUME DECLINE 0F 96% FROM 2005 TO 2012
FOREIGN BANKS TYPICALLY PROVIDE 35% OF THE LOC ACTIVITY, BUT
PROVIDED 36% OF THE MARKET IN 2012.
Data Source: Thomson Reuters as of June 30, 2013
133,528
177,989 190,118 194,367
232,339
190,598 200,226
72,172
35,401 26,765 15,249 13,273 5,637
12,941
15,468 14,598
23,303
26,957
21,040 20,483
71,226
20,503 11,662 9,760 6,063 789
0
50,000
100,000
150,000
200,000
250,000
300,000
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1H13
Am
ou
nt
($ M
ln)
New Issue Bond Enhancement Types
Bond insurance LOC Domestic or Foreign Bank
Information Security Identification: Confidential
Top Bond Enhancers in 2012-1H2013 Municipal Debt Market
4
TOP ENHANCER AGM IS THE TOP BOND INSURANCE
PROVIDER, WHILE PERMANENT SCHOOL FUND
GUARANTEES TEXAS EDUCATION BONDS.
THESE TWO ACCOUNT FOR 40% OF ALL ENHANCEMENT IN
2012-1H13
Bond Enhancers
Principal
Amount ($ mln) Rank
Mkt Shr
(%) # of issues
AGM formerly FSA Inc 16,634.2 1 3.1 1429
Permanent School Fund 12,220.2 2 2.3 527
Michigan Sch Bond Qual & Loan 2,604.6 3 .5 151
Washington SD Enhanced Program 2,501.8 4 .5 104
Colorado Intercept Program 2,162.1 5 .4 70
Build America Mutual (BAM) 2,154.8 6 .4 294
Minnesota SD Enhanced Program 1,813.0 7 .3 186
New Jersey School Bond Reserve 1,662.5 8 .3 140
Indiana Intercept Program 1,492.3 9 .3 152
Issuer 1,340.7 10 .3 10
Industry Total 537,160.8 - 100.0 18,664
Data Source: Thomson Reuters as of June 30, 2013
Information Security Identification: Confidential
Bond Enhancers by Type of Enhancement 2012-1H2013
5
MOST ENHANCEMENT TYPES ARE
SUPPORTED BY 1-2 TOP ENTITIES,
EXCEPT FOR LOCS WHICH ARE
FAIRLY EVENLY DISTRIBUTED
ACROSS THE TOP US BANKS.
Data Source: Thomson Reuters as of June 30, 2013
Guaranteed Enhancers
Principal
Amount ($ mln) Rank
Mkt Shr
(%) # of issues
Permanent School Fund 12,220.2 1 28.9 527
Michigan Sch Bond Qual & Loan 2,590.5 2 6.1 150
Washington SD Enhanced Program 2,501.8 3 5.9 104
Colorado Intercept Program 2,162.1 4 5.1 70
Minnesota SD Enhanced Program 1,813.0 5 4.3 186
Industry Total 42,236.0 - 100.0 2,533
Bond insurance Enhancers
Principal
Amount ($ mln) Rank
Mkt Shr
(%) # of issues
AGM formerly FSA Inc 16,634.2 1 49.1 1429
Build America Mutual (BAM) 2,154.8 2 6.4 294
Berkshire Hathaway Assurance 106.9 3 .3 1
Assured Guaranty 13.7 4 .0 2
Industry Total 33,870.5 - 100.0 1,726
LOC Domestic Bank Enhancers
Principal
Amount ($ mln) Rank
Mkt Shr
(%) # of issues
Wells Fargo Bank 830.4 1 17.5 13
Citibank 695.0 2 14.6 4
PNC Bank NA 576.4 3 12.1 11
US Bank NA 543.7 4 11.4 10
J P Morgan Chase 529.9 5 11.1 7
Industry Total 4,756.8 - 100.0 96
Mortgage backed Enhancers
Principal
Amount ($ mln) Rank
Mkt Shr
(%) # of issues
GNMA 1,263.3 1 60.4 30
FNMA 1,157.2 2 55.3 32
Federal Home Loan Mtg Corp 674.4 3 32.2 30
Cal-Mortgage - Hlth Fac Constr 355.4 4 17.0 11
FHA 56.8 5 2.7 5
Industry Total 2,091.9 - 100.0 74
Standby Purch Agreement
Enhancers
Principal
Amount ($ mln) Rank
Mkt Shr
(%) # of issues
Bank of America 324.4 1 12.5 2
Wells Fargo Bank 317.0 2 12.3 5
State Street Bank & Trust Co 300.0 3 11.6 4
The Bank of New York Mellon 220.5 4 8.5 3
Bank of Tokyo-Mitsubishi UFJ 216.0 5 8.4 3
Industry Total 2,586.7 - 100.0 30
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Using 501(c)(3) Bonds to Catalyze Social Impacts
Steve Eikenberry Senior Vice President First American Bank Elk Grove Village, IL
2
Steve Eikenberry
Senior Vice President
(847) 586 - 2231
First American Bank
1650 Louis Avenue, Elk Grove Village, IL 60007 - 2350
Fax: (847) 586 - 2231
Steve Eikenberry
Senior Vice President
(847) 586 - 2231
First American Bank
1650 Louis Avenue, Elk Grove Village, IL 60007
Fax: (847) 586 - 2231
• Introduction
• Credit Enhancement Options
• The Current Market
3
INTRODUCTION
• Since 2008, issuers have had few options for credit enhancement.
• Prior to the financial crisis, bond insurance penetration exceeded 50% of the total market. Letters of credit accounted for only about 5%.
• In 2008, bond insurance declined to just over 10%, while letters of credit increased to around 18% as many borrowers restructured their auction rate securities.
• By 2012, bond insurance had sunk to just 3.6% of the market, while letters of credit had declined back down to below 4%.
• The decline in L/C enhancement is due to credit stress and capital constraints at the larger banks, combined with downgrades of many regional bank providers.
• Many new issues are being sold as private placements without credit enhancement.
The financial crisis dramatically changed the credit enhancement landscape.
4
ENHANCEMENT OPTIONS
While tax exempt bonds bear higher issuance costs than conventional financing, these costs are more than offset by the lower interest rate. Bond Insurance Letters of Credit Private Placement
• No renewal risk • Primarily fixed rate – not a
liquidity facility • Supports long-term fixed rates • Typically available only for
better quality borrowers • Not subject to put risk • Subject to arbitrage costs
during construction period • Upfront fee can be financed,
but is sunk cost in the event of a refinancing
• In borrower default insurer continues to make payments
• Typically 3-5 year term • Primarily floating rate • Subject to renewal risk at end
of commitment • Subject to put risk based on
credit of bank or market demand
• In borrower default, bonds are called and paid off by bank
• Fee paid annually in advance • Swap or other hedge allows
for synthetic fixed rate • Pricing may increase or
decrease at renewal • May allow for more flexible
covenant package
• Most advantageous for smaller transactions
• Typically 3-5 year term • Fixed or floating rate only for
term of commitment • Multiple disbursements
eliminate arbitrage costs • Reduced documentation costs • Investor demand subject to
TEFRA disallowance and AMT • Subject to renewal risk at end
of commitment • Pricing may increase or
decrease at renewal • Not subject to put risk from
investors • May allow for more flexible
covenant package
5
THE CURRENT MARKET
• Uncertainty related to Dodd Frank and Basel III capital requirements have reduced bank’s appetites for letters of credit. In addition, banks have been reluctant to extend maturities beyond three years.
• Proposed capital rules appear to have a greater effect on the largest banks that provide the overwhelming majority of L/C enhancement.
• Low levels of interest rates have minimized the TEFRA penalty for non-bank qualified bonds, allowing more privately placed issues to be priced competitively.
• Over the last three years at the Illinois Finance Authority, only 18% of private activity bonds were L/C backed, while 75% were unenhanced private placements. Ten years ago, these percentages would have been reversed.
• Future uncertainty relating to changes in the tax code may limit bank’s appetites for purchasing tax exempt debt, or reduce the term of their commitment.
• Recently, auditors have begun calling attention to bond issues where the bank commitment expires in under one year, either classifying the debt as current, or noting the risk in a footnote.
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Using 501(c)(3) Bonds to Catalyze Social Impacts
Scott Richbourg Executive Director Build America Mutual New York, NY
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Using 501(c)(3) Bonds to Catalyze Social Impacts
Chris Chafizadeh Managing Director Assured Guaranty New York, NY
Credit Enhancement: Le0er of Credit & Bond Insurance Op:ons
Assured Guaranty Chris Chafizadeh
Build America Mutual Sco0 Richbourg
§ Why Municipal Bond Insurance?
§ Issuers and Investors Benefit (A Win-‐Win)
§ Economics of Bond Insurance – Issuer Savings
§ Insurance Market Overview
§ AcEve Insurers in the Market
2
Overview
§ Municipal market is very different from corporate model
§ Over 50,000 issuers of municipal bonds
§ Less than 1,000 Corporate issuers
§ Municipal issuers tend to be lesser known and less liquid
§ RelaEvely speaking the municipal market is not very efficient
§ Comparison with Corporate Market § Number of issuers § Complexity of security § Serial vs. Term § Call features § Availability and Emeliness of informaEon § Higher trading costs
3
Why Bond Insurance?
§ Interest rates and general credit concerns impact insurance value
4
Market Condi:ons Affect Value of Bond Insurance
-‐ Stable Interest Rates -‐ Low Credit Risk
-‐ VolaEle Interest Rates -‐ Heightened Credit Risk
Lower Value
Higher Value
Market is moving to a higher, more vola:le interest rate environment with increasing credit risk concerns
§ Issuer Benefits: § A lower cost of capital – interest rate savings § Broadened distribuEon (insEtuEonal & retail) § A simplified credit story for complex bond issues § EffecEve markeEng for small, lesser known names § Greater access to the capital markets § Certainty of ExecuEon
§ Investor Benefits: § UncondiEonal protecEon against issuer default § Superior credit selecEon § Greater price stability § Enhanced liquidity for secondary market trading § Simplified risk assessment § Dual events prior to a loss (underlying & insurer have to fail) § Surveillance & if necessary, RemediaEon
5
Benefits of Bond Insurance (A Win-‐Win)
§ Insurance Premiums approximate 50% of trading benefit
6
Bond Insurance Economics
Insured vs. Uninsured Bonds Trading Benefit*
AA-‐ A+ A A-‐ BBB+ BBB BBB-‐
General Obliga:on 6 12 15 20 25 35 50
Revenue Bonds 5 10 12 17 20 25 40
*Trading values vary based upon insurer, underlying sector and raEng
EsEmated Net Issuer Savings = 1% of Par
YTD, bond insurance has saved municipal issuers over $50 million in interest costs
7
Insurance Market Overview
General Obliga:on
60%
U:li:es 17%
Tax-‐backed 10%
Higher Ed 5%
Healthcare 3% Trans
5%
Sector Breakdown Ra:ng Breakdown
§ Average raEng of “A” category. § Average deal size = $10 million to $50 million § Current Insurance PenetraEon = 3-‐5% of Par and 7-‐10% of Issuers § Target Insurance Market = 20-‐30% of overall market
AA-‐ 3%
A+ 40%
A 30%
A-‐ 10%
BBB+ 8%
BBB 8%
BBB-‐ < 1%
§ Currently Ac:ve Insurers are Be0er than Before: § Insure only Municipal Bonds § Focus on the Safer Municipal Sectors § Lower Leverage § Smaller single risk exposures § Primarily fixed rate bonds
8
Insurers: Be0er than Before
Current Insurers are more conserva:ve and offer greater value to issuers and investors
9
Ac:ve Insurers
Assured Guaranty
§ AGM (AA-‐ S&P/A2 Moody’s) § MAC (AA-‐ S&P/AA+ Kroll)
Build America Mutual
§ BAM (AA S&P)
Contact
Chris Chafizedeh (212) 339-‐0832 [email protected]
Contact
Scop Richbourg (212) 365-‐7562 [email protected]
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Tony Portuondo Managing Director 904-645-1952 [email protected]
The material contained herein is for informational purposes only. The content of this is not intended to provide authoritative financial, legal, regulatory or other professional
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